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Source: E-mail dt. 5 September 2011

A Comparative Study on SHG Bank Linkage Programme and MFIs Model

                                                           

Dr. P. Ishwara

Associate Professor,

Department of Commerce,

Mangalore University, Mangalagangotri, Konaje – 574 199

Karnataka, India

 

Abstract

 

At present, micro finance institutions are passing through a difficult time as some of their business practices, including charging of high interest rates and resorting to strong- arm loan recovery methods, have placed them under the lens of state Governments.  There are complaints that the MFIs are coercing the poor for borrowing and for repayments.  This has led to severe back lash in some states like Andhra Pradesh. Dr C. Rangarajan, PMEAC chairman stated “MFIs are already linked to the banking system. But if this link is to be strengthened, and if this link is to become a really significance one, MFIs need to modify some of their lending practices”.

 

In this direction an attempt has been made to know the ground reality of cost involved through the comparison of MFIs and Self- Help Groups (SHG).The SHG Bank Linkage Programme (SBLP) has contributed significantly to making credit available to the rural poor, but the true costs and risks inherent in this model need to be better understood. In SHG model almost 75 per cent of the origination costs are borne by the SHG members. Of this, a significant chunk-nearly 60 per cent-is contributed by the opportunity cost of time spent by members in trainings and meetings conducted for forming the group.  This time could have been spent in other, remunerative activities. Typically, the direct costs to the SHG of forming one group, amortized over the life of a group, represents 3 % of a loan of Rs 50,000 per group (a part of this cost is borne by the SHPI).

 

MFIs charge 24-30 per cent interest rate and operate with a spread of 12-16 percent; this amounts to Rs.600-800 more than what a bank would charged on an average Rs10,000 micro finance loan over one year.  In the period of a year the customer has to be serviced 50 times, which is Rs 16 per visit.  The higher cost of Rs 800 compared to a bank, comes with doorstep service for small, convenient installment repayments, speedy, non –bureaucratic loan disbursals and access to borrowing without collaterals.  This cost must be viewed against the opportunity cost for the customer of loss in labour days if he has to access regular banking channels, in addition to the very high possibility of not getting any credit. The opportunities for investment for the poor in the countryside are mind-boggling. 

 

Sa-dhan the country’s largest umbrella body of MFIs-should create a national database of district-level MFI operations to prevent an overlap of more than one MFI operating in the same area and instances of multiple-lending

 

Full Paper

Microfinance has had a distinguished author in Mohammad Yunus and offers a shining example in the Grameen bank. But in India the idea took a different route with scheduled banks funding Micro Finance Institutions (MFIs) whose numbers had grown to around 3000 over a two-decade period. Of these 400 were active till recently, according to a study by Crisil. Mohammad Yunu’s brainchild appeared to be working well, per-haps too well. When SKS microfinance went public in early August and was oversubscribed 13 times, inspiring other private firms in the business to follow its example. At present, micro finance institutions are passing through a difficult time as some of their business practices, including charging of high interest rates and resorting to strong- arm loan recovery methods, have placed them under the lens of state Governments.  There are complaints that the MFIs are coercing the poor for borrowing and for repayments.  This has led to severe back lash in some states like Andhra Pradesh. The AP Government recently has responded to this with a seemingly draconian ordinance to control the operations of the micro finance institutions in the state.  This has temporarily blocked the recoveries in the sector jeopardizing nearly Rs 7000/- crores outstanding money in the state.  The Prime Minister’s Economic Advisory Council (PMEAC) has called microfinance institutions to reform business practices, and has underscored the need for a regulatory oversight on the sector. Dr C. Rangarajan, PMEAC chairman stated “MFIs are already linked to the banking system. But if this link is to be strengthened, and if this link is to become a really significance one, MFIs need to modify some of their lending practices”.

 

In this direction an attempt has been made to know the ground reality of cost involved through the comparison of MFIs and Self- Help Groups (SHG).The SHG Bank Linkage Programme (SBLP) has contributed significantly to making credit available to the rural poor, but the true costs and risks inherent in this model need to be better understood.

 

SHG Bank Linkage Programme (SBLP)  

 

Under the SBLP, a SHG with 10-20 members (usually woman) is formed with the support and guidance of a self-help promoting institution (SHPI).  The SHG members are encouraged to make voluntary savings, which is internally lent. After assessing the savings discipline and credit history of the group, usually for 6-8 months, the SHPI links the group to a bank. The banks then make loans to the SHGs in certain multiples of their accumulated savings, which the group in turn lends to its own members at a higher rate-24-48 per cent per annum.  The group members are responsible for holding meetings, and collecting and reaching repayments to the nearest bank branch.  So, in effect, SHGs operate as quasi-banks, using the member’s savings and loans from banks to on-lend to their own members.  It is important to note here that this structure exposes the savings of member to local risks and hence, may not be as secure as formal savings.  SHPIs typically step back after the groups are linked to banks and their monitoring role vis-à-vis the group discipline is not explicit.

 

Comparison of SBLP and MFIs Model

 

In the MFI model, the MFI borrows from various sources (usually banks) and on-lends to clients, who are usually organized in five-member joint liability group.  Interest rates to the client vary between 24 per cent and 48 per cent per annum.  There are, however, significant difference is the two models, in the cost of origination (that is, costs incurred in forming groups, maintaining register, etc.), the opportunity cost of the group members, the collection costs and the loan losses.  These costs are incurred by the clients, SHPI, and bank in the SBLP model.  Let us look deeper into these and see how the different costs are borne by the different players in the model.  In the SBLP, the SHPI does not lend to groups, the bank lends directly to groups indentified and promoted by the SHPI.  The cost of creating the groups is usually provided the government, NABARD or other donors in the form of a grant and not compensated by the bank.  Therefore, the cost of origination borne by a SHPI, though significant, typically goes unaccounted for.

 

Costs to SHPI and SHG

 

Almost 75 per cent of the origination costs are borne by the SHG members. Of this, a significant chunk-nearly 60 per cent-is contributed by the opportunity cost of time spent by members in trainings and meetings conducted for forming the group.  This time could have been spent in other, remunerative activities. Typically, the direct costs to the SHG of forming one group, amortized over the life of a group, represents 3 % of a loan of Rs 50,000 per group (a part of this cost is borne by the SHPI).  Since banks lend directly to the groups, the SHPI does not monitor repayments or manage collections.  Instead, the members are expected to visit the bank and make repayments on their own.  Often, a visit to the bank branch could mean a loss in wages for the client for that day.  The group members themselves have to manage the entire repayment collection process, including maintaining records, resulting in significant administration cost.     Our estimate shows that this function, along with time spent in loan repayments operations, effectively ends up costing the group members about 8 per cent of the loan amount of Rs 50,000 that the group receives from the bank.  This cost is incurred in the form of wages foregone because of group meetings (5.4 per cent), visits to banks is terms of opportunity cost(0.45 per cent), and maintaining accounts (1 per cent), as well as the costs of travelling to the bank branch(1.15percent).     So, the SHG members actually incur a significant amount of hidden cost, which increases the cost of accessing the credit under the SBLP model beyond the ‘sticker costs’. 

In the MFI model, in contrast, there is a significant cost attached to the institution in running its operations in the form of staff and administration cost is almost negligible for the client, who can repay at her doorstep, every week.

 

Interest Rate Misnomer in MFIs

 

Interest rates are a percentage-but of the principal amount, and when small amounts are discussed percentage can be misleading.   MFIs charge 24-30 per cent interest rate and operate with a spread of 12-16 percent; this amounts to Rs.600-800 more than what a bank would charged on an average Rs10,000 micro finance loan over one year.  In the period of a year the customer has to be serviced 50 times, which is Rs 16 per visit.  The higher cost of Rs 800 compared to a bank, comes with doorstep service for small, convenient installment repayments, speedy, non –bureaucratic loan disbursals and access to borrowing without collaterals.  This cost must be viewed against the opportunity cost for the customer of loss in labour days if he has to access regular banking channels, in addition to the very high possibility of not getting any credit. The opportunities for investment for the poor in the countryside are mind-boggling.                     A young goat bought at Rs 2,000 can be sold at Rs 5,000 in six months of fattening.  That is a 300 per cent annualized return.  An Rs 15,000 investment in a cow can fetch revenue of Rs200 a day on milk and a profit of Rs 3,000 per months.  That is more than 100 per cent returns annualized, even accounting for non-lactating periods.  The rate of interest on MFI loans should be viewed against this perspective.   People need capital to magnify investments of their labour, and at the micro level the timely availability of capital is the difference between a viable activity and wasted labour.

 

Cost to the banks in SHG Model   

 

Unlike the MFI model, where the institution intermediates between the bank and the clients and the relationship between the bank and the MFI is wholesale, there is considerable time spent by the branch staff in the SBLP, at the time of providing loans and servicing the accounts of the SHGs.

 

According to the Rangarajan Committee report, the rate of 12 per cent at which banks lend to SHG, is 10-20 per cent lower than the ‘true total costs’ of a bank.  Even if we take a conservative estimate, this cost is likely to be much more than what is accounted for in the interest rate currently charged. MFIs make a provisioning for loan loss, which is built into the final interest rate charged to the client.  This is usually about 2 per cent of the overall portfolio for MFIs.  In the case of the SHPI, once the groups are linked to banks, it is up to the bank to make such a provisioning, as they would bear the ultimate default.  According to the Nabard Managing Director, Mr. K.G. Karmakar, the default rate in SBLP was around 12 percent in 2008-2009 and is increasing. It is likely that the bank takes some expected default into account when it prices the loan to the SHG groups at 12 per cent but it is not likely that it takes more than 1-2 percent as expected loan loss.  So, even after accounting for this provision, there is an additional loan loss of about 10 per cent on the portfolio.  If the banks were pricing the SHG loans as per the actual portfolio performance, their interest rates would be much higher.   As for PUS bankers in rural areas, most are either too overburdened, or too disinterested to bring about real financial inclusion.                          

 

Need of the Hour

 

It is a practice prevalent in micro finance where customers borrow from many MFIs.  Multiple lending is a phenomenon created by the MFI industry in its urgency to grow and in its reluctance and inability to lend the right amount to meet each customer’s full needs. This poses a problem for the customers, but is also a big bugbear for the MFIs as it brings in competitive pressures and, more significantly, obfuscates the customer’s current debt level and cash flow situations.  It is a fact that multiple lending does lead borrowers into debt traps, especially when the poor borrower has emergency needs to be met.   An exclusive relationship between the customer and an MFI would put the onus directly on MFIs in the event of debt traps.

MFIs achieve high repayment rates because of the group liability.  There are no guarantees and no collaterals.  Discipline and joint liability are at the heart of micro finances, enabling regular receipts of the money.  There is a fine line between being benevolent and creating a moral hazard.  MFIs have spent years getting the poor to maintain credit discipline, and now politicians are tempting them with potential loan waivers.  MFIs need to arrive at the right balance between strictly enforcing group liability and allowing exceptional defaults, but still keeping the group mechanism relevant. 

 

Conclusion

 

Borrowers taking loans from microfinance institutions (MFIs) must pay back one loan before taking another.  They may no longer be allowed to indulge in “multiple borrowing “from the same MFI or from more than one.  Similarly, MFIs may also not be permitted to lend to an individual who has an outstanding loan.  The Government is likely to tackle this issue through the Micro Finance Bill by incorporating provisions that will help identify wrong-doers and discourage these practices..                                                                                                           

 

In this regard, the Ministry should hold talks with the Unique Identification Authority of India to evolve a system to identify persons availing themselves of multiple loans so that they will not be eligible for loans if they do not repay.  It is also come to know that, there are instances where people have take more than one loan from MFIs under different or bogus names.  It has noted cases where persons have taken advantage of the differential rates of interest offered by different institutions and used the loan amount from one to pay the other.                                                                                                                               It has observed that owing to competition, some MFIs have resorted to multiple-lending without looking at the repayment ability of their customers.  There have also been instances of ‘ever-greening’ of loans by MFIs where they have provided fresh loans to borrowers to help them repay the old ones, instead of defaulting.  MFIs allegedly resort to such practices in a bid to grow fast, increase profits, and investment and even to go in for initial public offers.    Industry sources said MFIs would be soon forced to write-off loans in the multiple-lending category.  Sa-dhan the country’s largest umbrella body of MFIs-had attempted to create a national database of district-level MFI operations to prevent an overlap of more than one MFI operating in the same area and instances of multiple-lending.  But the exercise is yet to take off as MFIs have not furnished details, they said.                                                                           

 

“Sa-dhan members have decided to move towards reducing loan size per household to a limit of Rs 50,000 and practicing within 30 days the Sa-dhan code of conduct on transparency, governance, anti-coercive practices and training of field workers.

 

References

 

1.      Micro finance in India: A state of the sector report, 2007- by Prabu Ghat

2.      Micro finance in India: issues and challenges- by J V ahmed,D Bhagat.

3.      Savings of the poor-by Shankar Datta.

4.      Banking services for the poor- by Robert Peek.

5.      Business Line News papers on Nov 9th, 12th, 17th, and 23rd 2010.